You are on page 1of 3

FINA2320/2802D Fall 2016: Homework #1

Due: 6pm Friday, October 7


(50 points in total)
1. (15 points) Suppose that Facebook is selling at $75 per share at the beginning of 2016.
You are bullish on Facebook stock, and want to buy 1000 shares on margin. The initial
margin is 50%. You can borrow from your broker for one year (till the beginning of
2017) at an interest rate of 6%.
(a) How much do you invest using your own money? How much do you need to borrow
from your broker? (2 points)
(b) Assume that Facebook pays a year-end dividend of $2.5 per share. Assume that you
dont get any margin call during 2016. What will be your holding period return in 2016 if
the stock ex-dividend price of Facebook
(i) goes up by 10%
(ii) is still $75
(iii) goes down by 10% during the next year? (6 points)
(c) How low can stock price fall before you get a margin call, if the maintenance margin
is 25%? (2 points)
You are bearish on Facebook stock, and want to sell short 1000 shares at current price.
The initial margin is 50%.
(a) Assume that you earn no interest on the funds in your margin account. Facebook
currently does not pay dividend. Assume that you dont get any margin call during 2016.
What will be your holding period return in 2016 if the stock price of Facebook
(i) goes up by 10%
(ii) is still $75
(iii) goes down by 10% during the next year? (3 points)
(b) How high can stock price rise before you get a margin call, if the maintenance margin
is 25%? (2 points)

2. (5 points) You are considering an investment in mutual fund ABC.


(a) It has a NAV per share of $20 on January 1, 2009. On December 31 of the same year,
the fund's NAV is $20.20. Income distributions were $1.19 and the fund had capital gain
distributions of $0.81. Without considering taxes and transactions costs, what is the total
rate of return to an investor in this fund during 2009? (1 points)

(b) Assume that fund ABC will keep the same rate of return for the next 10 years. It sells
Class A and B shares with different fee structures (shown in the following table). If you
plan to sell the fund after 3 years, are Class A or B shares the better choice for you? What
if you plan to sell after 10 years? (4 points)

Front-end load
Back-end load
Expense ratio
12b-1 fee

Class A

Class B

5%

0%
5% at the beginning of the first year, fall
by 1% every year (until 5th year)

0%
1.25%

1.5%

0%

0.5%

3. (20 points) You are considering the investment in stock XYZ. The stock price at the
end of this quarter is $50. The stock pays no dividends.
(a) Suppose your forecast regarding the distribution of stock price at the end of next
quarter is as follows:
State of the
Market

Probability

Ending
Price

Boom

0.20

$55

Normal

0.55

$53

Recession

0.25

$46.5

HPR
(next quarter)

Please fill out the table by computing the HPR in the next quarter in each state of the
market. Also compute the expectation and standard deviation of quarterly HPR on this
stock. Suppose that the current rate of return on 30-day T-bills is 5% and will be constant
over the next quarter, what is the quarterly risk premium and Sharpe ratio? (6 points)
(Note: the quoted 30-day T-bills rate is annual rate of return APR.)
(b) In reality, investors do not know the true distribution of stock returns. So we use
historical data to estimate the performance of this stock. We can observe the quarterly
rate of returns data of stock XYZ in the past 25 years (which is 100 quarters).
(i) If we only use the quarterly return data in the past four quarters: 12%, 5%, 7%, 8%, what are the arithmetic average, geometric average, and standard deviation of the
sample rate of return?

If we also observe the quoted 30-day T-bills rate in the past four quarters: 5.6%, 5.2%,
5.2%, 4.4%, what are the sample risk premium and Sharpe ratio? (5 points)
(ii) Discuss the advantage and limitation of previous time-series analysis using the
most recent return data. (4 points)
(iii) Now, we use all the 100 quarterly rate of returns data of stock XYZ. The statistics
of quarterly excess returns are given in the following table:
Statistic (Quarterly excess returns)

Performance (%)

Average

2.25%

VaR actual

-8.02

SD

6.12%

VaR normal

-7.82

LPSD

6.59%

Expected shortfall actual

-10.11

Skew

-0.6

Expected shortfall normal

-9.81

Kurtosis

0.94

Compute the Sharpe ratio and Sortino ratio. What does the distribution of excess returns
look like, based on these sample statistics? (5 points)

4. (10 points)

(a) On the basis of the utility formula above, which investment would you select if you
were risk averse with A = 4? (4 points)
(b) On the basis of the utility formula above, which investment would you select if you
were risk neutral? (2 points)
(c) Draw the indifference curve of Investment 3 with risk aversion A = 4. (4 points)